Definition of 'Knock-Out Option'
An option with a built in mechanism to expire worthless, should a specified price level be exceeded. A knock-out option sets a cap to the level an option can reach, in favor of the holder. As knock-out options limit the profit potential for the option buyer, they can be purchased for a smaller premium than an equivalent option without a knock-out stipulation.
Investopedia explains 'Knock-Out Option'
For example, an option writer may write a call option on a $40 stock, with a strike price of $50 and a knock out level of $60. This option only allows the option holder to profit up to $60, at which point the option will expire worthless, thus limiting the loss potential for the option writer.
Knock-out option are considered to be exotic options and are primarily used for commodities and currency options.